Natural resources, or commodities, are not an asset class per se. People refer to natural resources and put all commodities together just like emerging markets — this is a mistake. Just like one emerging market is very different from another, different natural resources are driven by very different factors.

Commodity ETFs are widely popular, as well as index funds that invest in commodities, but I prefer producing companies rather than those instruments (precious metals ETFs are the only exceptions). I have used the example before for oil, oil stocks and the U.S. Oil Fund ETF (NYSE: USO) which is an ETF that invests in oil futures. It is interesting to see that so far this year the front-month futures contract shows a loss of 3.96% while the USO ETF shows a loss of 13.03%. It is only the middle of the year and you have lost +10% in the ETF more than you would have in the front-month futures contracts. If oil prices stay flat and the futures curve stays in a similarly-sloped “contango” until the rest of the year, you would be down 20% in the ETF even though oil remained flat. This is simply a terrible deal for longer-term investors, though it does work for short-term trading.

In a contango, every following month’s futures contract is priced slightly higher than the previous month. This is because the futures market is saying oil is plentiful now — therefore the lower price — but not so plentiful in the future. The opposite of contango is backwardation, where prices decline in the future — that means the commodity is in short supply at present, but in the future abundance is expected (this happens a lot with grains around bad harvests).

So right now the August oil contract goes for $76.54 and every following month until the end of the year and beyond we are 25 or 50 cents higher; the December contract goes for $78.32. December 2015 oil goes for $85.45. Sometimes the slope of those future curves is steeper — that means bigger losses for ETF investors — sometimes it is not as steep, but as long as the futures’ curve is positively sloped, you are guaranteed to lose money over time.

This is why I don’t like futures ETFs. Futures were never intended for buy-and-hold investors, but for producers and consumers of the commodity that wanted to lock-in guaranteed delivery for specific dates. Do you know of any retail investor that wants to take delivery of oil contracts? I didn’t think so.

Retail investors are better off with companies with rising production volumes and good reserves, like Lukoil (OTC: LUKOY), ConocoPhillips (NYSE: COP), Occidental Petroleum (NYSE: OXY) and China National Offshore Oil Corporation (NYSE: CEO). However, I recommend that you stay away from BP (NYSE: BP) as the well cap is leaking and the company is about to be gutted with asset sales in order to pay for the damages. Yes, this is great “trading stock,” but not one to buy now and forget about — I would, however, do that with Lukoil.

We have the same monthly “death by 1000 cuts” issue with many commodity ETFs or ETNs; it’s not just oil. For instance, there is the ELEMENTS Rogers International Commodity Index (NYSE: RJI), which has the same problem. Since many buy-and-hold investors are sold on the future of natural resources like me — I do believe that oil is going to $300 based on shrinking supplies and rising demand — they are willing to wait. The chart below shows why this is a mistake.

Over the past three years oil futures are flat (despite the volatility); the USO is down 40%, while CEO is up 37%. Which one is best for long-term investors?

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